What’s the deal with carbon pricing?

by Magnus Haw

Many of us have heard the term “cap and trade” bandied about by the media, but somehow they never mention its carbon pricing siblings: “fee and dividend” and “tax swaps”.

So what are all these caps, fees, dividends, and swaps?

– “Cap” refers to regulations that limit the total amount of greenhouse gas (GHG) emissions for a given time period; in other words, the state/nation/world has set itself a yearly maximum allowance of GHG.

– “Trade” refers to how an emissions allowance is distributed among carbon emitters; generally this takes the form of a government auction that occurs every couple of years.

– “Fee” refers to a fee levied on extracted fossil fuels based on their emissions potential. – “Dividend” refers to a check that citizens will receive based on the carbon price revenue.

– “Tax swaps” are an exchange of taxes. For example, an increased tax on fossil fuels will be exchanged for an equivalent decrease in income tax.

Now that all the jargon has been dealt with, how do these carbon pricing schemes work? Cap and trade operates by setting a cap and auctioning the carbon allowance credits to the highest bidders. Since the cap (or allowance) decreases over time, the number of available credits decreases and the auction price of each credit rises as GHG emitters compete for fewer credits. California’s AB32 law is an example of the cap and trade approach.

Now that we’re somewhat familiar with cap and trade, what the heck is fee and dividend? Fee and dividend focuses exclusively on extraction instead of emissions. A fee is levied on extraction and the revenue is distributed among the citizens as a dividend. This approach is designed to eliminate the need for regulatory oversight for each carbon emitter and to avoid speculative instabilities associated with auction markets.

Tax swaps are simple: taxes on fossil fuels go up, your income tax goes down. The tax revenue the government gains from these policies is generally small to zero; if zero net revenue is obtained by the government, the policy is called revenue-neutral and all the money collected goes back to the people in the form of reduced income tax. The Canadian province of British Columbia provides a working example of a revenue-neutral tax swap.

The various approaches can be combined and interchanged, so there is a veritable cornucopia of carbon pricing schemes: “cap, trade, and dividend”, “revenue-neutral fee and dividend”, “cap and trade”, and “revenue-positive carbon tax swap” are all examples of possible approaches.

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